by Russ Wiles The Arizona Republic Feb. 14, 2010 12:00 AM
Hold it or fold it?
It's one thing to throw back lousy cards in a poker game and quite another to walk away from a money-losing home that you can still afford.
Yet, more people are doing just that as they find themselves "underwater," with mortgage debts that exceed the worth of their properties.The government, financial industry, media and other "social-control agents" have fomented a culture of fear and shame about foreclosures that's preventing many people from abandoning properties, contends Brent White, an associate law professor at the University of Arizona.
Rather, homeowners should take a cue from corporate America and cut losses, treating underwater homes like any other investments gone sour, he suggests.
But the prospect of mass "strategic defaults," where homeowners who can afford their payments nevertheless walk away, has sparked sharp words from both sides. That's partly because these actions don't just affect borrowers and their lenders, but other parties, too.
"If everyone thought that way, what would it do to our whole economy?" asked Gina Gallegos, an entrepreneur and Ahwatukee homeowner who worries about foreclosures in her area.
People who walk away drive down the value of home prices in neighborhoods, undermine homeowner-association finances and cause other damage.
"All in all, it's the wrong approach to take," Gallegos said.
In a December research paper, White didn't delve much into the broader impact, but in an interview he took a shot at homeowners who criticize neighbors who walk away.
"They're really concerned about the value of their homes," he said of the critics. "It's all self-interest."
But abandoned properties aren't just eyesores and don't merely hurt local home values. They also can generate problems ranging from abandoned pets to heightened public-safety hazards.
"There are increased risks any time you have a property that's vacant and uninhabited for a lengthy period," said Ron Williams, executive director of the Arizona Insurance Council.
Abandoned homes often aren't well maintained, and that can translate to various losses. Insurers might pass along those costs to other customers in the form of higher premiums, he said.
The cost and availability of mortgage credit also could be affected if more underwater owners abandoned their properties.
"We're learning as an industry that the ethics is changing," said Tanya Wheeless, president and chief executive officer of the Arizona Bankers Association. "You used to be able to count on people sticking with a mortgage."
Although interest rates on conventional home loans remain low, that's due largely to government intervention that may not last long. Wheeless pointed to credit costs in the jumbo-loan market - which are much higher - as a better reflection of the impact from defaults.
White counters that reduced credit availability might not be so harmful since lax credit kindled the crisis in the first place by allowing poorly qualified individuals to buy homes, often with little or no down payments.
"It's not necessarily a bad thing in the long term if people have to put more money down to buy a house," he said.
What about the impact on banks themselves?
White blames financial institutions for bringing on these problems with easy-money policies during the height of the market several years ago.
"It's unfair to make homeowners responsible for the state of banks," he said.
That may be, but past lending practices don't change the risks posed by future bank failures. According to Wheeless, those banks facing a disproportionate share of the fallout are small community banks that didn't receive any federal bailout assistance.
Each foreclosure reduces a bank's capital, which directly crimps its ability to make loans and undermines its solvency.
"That's money coming out of the community that we can't replace," she said.
In 2009, seven Arizona banks failed, up from one over the prior six years.
Bank failures, in turn, could imperil some depositors and may show up as a cost to taxpayers. Those factors, plus any general curb on lending, would take a toll on the economy.
But White argues the economic impact isn't so negative as it might seem. He predicts underwater consumers would start spending more money once they throw off the yoke of high, unsustainable mortgage payments.
"A lot of these people aren't spending because they feel poor from being mired with perhaps $200,000 in negative equity," he said. "They just don't have much discretionary income."
White said he disagrees that more strategic defaults would seriously hurt the economy or even home prices.
"I don't think prices in Phoenix would fall that much more, since they already have fallen so much," he said.
White also said he hoped any uptick in defaults would make banks more willing to modify mortgages and write down debt amounts - a notion that Wheeless considers unlikely.
"We would have seen that already," she said.
And what of the impact on borrowers themselves?
People who walk away from a mortgage will suffer a hit on their credit scores, but this impact is hard to quantify.
FICO, which operates the industry-standard scoring system, recently reported that the damage largely depends on a person's initial score and ongoing credit behavior.
As examples, someone with a good initial score of 780 (on FICO's scale of 300 to 850) could expect a foreclosure to shave 140 to 160 points, while another person with a weak score of 680 would likely suffer a drop of 85 to 105 points.
At any rate, White said he believes the credit-score damage would dissipate within a couple of years. More to the point, he argues borrowers shouldn't feel shame, guilt or similar emotions from walking away.
"It's not appropriate to prop up the market on their backs," he said.
Defaulting on mortgages: Who views it as wrong
A study last year by researchers at Northwestern University and the University of Chicago highlighted certain trends:
Price declines: Homeowners generally refrain from defaulting as long as their negative equity doesn't exceed 10 percent of a dwelling's value, researchers said. But once it hits 15 percent, they walk away "massively."
Age: People under 35 and over 65 are less likely to say defaulting is morally wrong compared with those in the middle.
Education, race, income: People with higher education and Blacks are less likely to view defaults as morally wrong, according to the researchers. Those with higher incomes are more likely to view it as wrong.
Politics: The researchers didn't spot a difference in the views of Republicans and Democrats, but independents were less likely to say defaults are immoral. Also, people who support government efforts to help homeowners are less likely to view defaults as wrong.
Sources: Researchers Paola Sapienza, Luigi Zingales and Luigi Guiso
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